The FTSE 100 is filled with high-yield income stocks. And among the top five are Vodafone (LSE:VOD) and British American Tobacco (LSE:BATS), offering yields of 10.8% and 9.2% respectively. Both are leaders in their respective industries and it seems likely neither business is going to disappear any time soon.
So does that make them top stocks to buy while shareholder payouts are still high? Sadly, the answer might be no. Let’s take a closer look.
Telecommunications are critical but expensive
In my experience, seeing a double-digit yield is usually a sign to stay away. Why? Because instead of being created by a jump in dividends, it’s often formed by a drop in share price. And this, in turn, is usually caused by negative investor sentiment.
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Looking at Vodafone today, there’s plenty to be negative about. For starters, sales are still shrinking along with earnings. The debt load is proving increasingly problematic, and the return on capital employed (ROCE) has hovered consistently below the industry average for years.
Needless to say, these aren’t the traits of a healthy income stock. However, the stock isn’t without some merits. For starters, Vodafone is fully aware of these issues and has brought in a new CEO to turn the ship around. The recovery strategy includes some internal restructuring as well as job cuts to try and streamline operations.
If successful, the telecommunications giant could propel itself to new heights. However, this isn’t the first time a turnaround plan has been announced. And at this stage, I’ll believe it when I see it.
Therefore, while I can see some potential here, the risk doesn’t match the potential reward, in my opinion.
An unloved tobacco stock
British American Tobacco is one of several ‘sin’ stocks in the UK’s flagship index. And that automatically places it in a relatively unpopular category among most investors. After all, not everyone is keen to own a tobacco giant, given the moral implications of selling harmful, addictive products.
However, because of this lack of popularity, the stock has consistently offered a high yield to income investors.
Many seem to assume the gravy train won’t last forever as more consumers avoid or give up smoking in the interest of their health. But management isn’t blind to this trend. That’s why a large amount of capital has been invested in newer non-combustible products like vapour, HTP, and oral pouches, which are deemed less harmful.
And looking at the latest results, it seems this division is making impressive strides. Sales in the first half of 2023 hit £1.7bn, with losses falling by 94%! That places it well on its way to reaching the goal of £5bn in sales by 2025.
The regulatory environment surrounding cigarettes becomes stricter every year so a similar story may emerge with its newer products, where the jury is still out on any long-term side effects. With the vast majority of cash flow still stemming from traditional cigarettes, this could prove disruptive as management transitions the product portfolio.
However, British American Tobacco seems to have a long track record of defying expectations. So compared to the Vodafone yield, this income stock looks a far better opportunity, in my eyes.
But like many other investors, I’m not interested in holding in a tobacco company, even with the potential for handsome payouts.
